Why pre-funding end-of-service benefits is critical for business continuity

Generally, all employees in the UAE are entitled to end-of-service benefits (EoSB) – a form of appreciation for employee efforts paid upon the termination of a contract that usually accumulates with the tenure served.

In the UAE, and across the GCC, the legal entitlement under EoSB is the equivalent of 21 days (for the first five years of service) or one month’s salary (after first five years of service) for every year of employment completed, depending on the years of service.

This payment is generally unaccounted for, leading employers to dip into corporate capital and putting strain on business cashflows. This has been a long-term issue for many businesses and can lead to disruption in corporate operations. To ensure a seamless transition, employers must be prepared to settle EoSBs while minimising the impact on the business continuity.

The UAE is now being considered a long-term, retirement destination for expats residing in the country. The government recently launched new regulations, including a five-year retirement visa, that allow expats to envision a future in the UAE.  However, a recent study by HSBC stated that UAE residents are not saving for life after retirement, with a majority of 76 per cent failing to save during their working years. This indicates that with the newly introduced regulations, it will be difficult for expats to maintain a comfortable lifestyle after retirement. In fact, 59 pe cent of expats are completely relying on their EoSB or end-of-service gratuities to fund their golden years.

Additionally, with the recently announced visa regulations, it is expected that expats will spend a longer period of time employed in the UAE, resulting in an increased amount of EoSBs to be paid at the end of their working period. Therefore, if an organisation fails to plan ahead for funding the employees’ cash out, additional strain will be inflicted onto its working capital.

To ensure organisations are prepared for such regulatory changes while avoiding financial strain associated with unfunded EoSB payments, the following best practices must be implemented.

1. Ensure that financial benefits promised to employees are pre-funded
2. Invest dedicated financial resources
3. Track the potential value of EoSBs over time
4. Develop an ‘EoSB fund’ for your employee

A simple and well-structured EoSB arrangement, such as setting aside one-month of each employee’s salary every year, can significantly reduce the cash cost to the employer. The employee’s EoSB fund can then be invested in a diversified asset portfolio. This way, the returns from the investment can be added to the fund and effectively reduce the cash cost for the employer as the payment is met by a combination of cash contributions and investment returns.

Securing and funding EoSB payments can be beneficial for both the employer and employee. Employers will attract and retain talent as EoSB pre-funding is a key differentiator for employers, and simultaneously, improve cash-flow and business continuity. For employees, such measures will instill a sense of security and motivation. While it can be difficult to accurately predict the timing of each EoSB payment, companies must plan ahead.

Companies in most developed countries are legally required to pre-fund the financial benefits promised to employees. Such regulations have been put in place to protect employee rights, while ensuring organisations effectively manage benefit payments without disrupting ongoing operations.

While the UAE’s current regulations encompass an obligation to pay the EoSB, there are no rigorous guidelines for funding the payments. However, in line with global trends to improve business activity and protect employee rights, the UAE has recently announced changes to EoSB regulations that will enforce adequate pre-funding in organisations. Several regulatory bodies in the UAE are also discussing forms of further mandatory benefits funding. The Dubai International Financial Center (DIFC) decided to move forward and under the proposed Employment Law reforms, the DIFCA is suggesting to phase out the existing end of service gratuity system and replace it with a funded workplace savings plan for expatriate workers.

The transition from the existing system that organisations use today must be gradual. The current benefit scheme must include a well-rounded plan with an added contribution source, such as the funds mentioned above. Failure to diversify funding with appropriate governance may cause a critical issue that will severely impact a company’s performance.

Singapore’s Central Provident Fund, for example, is a savings plan where both the employee and the employer contribute to a fund that is regulated and secured. Looking forward, the UAE will most likely adopt a similar system that will involve a central fund to eliminate financial strain once an employee decides to leave an organisation.

Tarek Zouiten is actuarial consultant – retirement business leader at Mercer